Historic gains in farm shares

Some of the world’s leading investment minds are spruiking agriculture as the next source of supercharged returns – and Australian investors don’t have to look far to take part, with the local sharemarket featuring plenty of ways to get exposure.

Often criticised for being two-dimensional, and heavily dominated by the resources and financial sectors, the Australian sharemarket features a refreshingly large amount of stocks related to agriculture – perhaps a legacy of farming’s once-dominant role in our economy.

The smart money is already onto the theme, with some shares in the sector posting eye-catching gains this year. Warrnambool Cheese & Butter is up more than 41 per cent in 2011, while RuralCo Holdings is up 27 per cent, and at $3.50 equalled its best close since November 2008 on Friday.

The rationale behind the push into agriculture is fairly straightforward – population growth and rising standards of living in China and India are creating unprecedented demand for food.

Legendary Wall Street investor Jim Rogers told The Australian Financial Review earlier this year he thought agriculture was shaping up as “one of the greatest investment opportunities of our time" but said he was surprised “agriculture seems to be ignored here [in Australia] more than I expected".

Meanwhile, GMO’s Jeremy Grantham said in a visit to Australia earlier this year that population growth, shrinking availability of fertile land and declining crop yields all pointed to a paradigm shift whereby soft commodity prices remain permanently elevated.

After years of being ignored by investors more focused on the resources boom, soft commodities captured the spotlight earlier this year, with prices of many reaching their highest levels in decades and in some cases centuries.

But investors looking to exploit the new-found interest in agriculture should be cognisant of the risks – the sector is notoriously cyclical and hugely dependent on weather.

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“In all honesty I avoid them. They are very cyclical and often of low quality, like some mining explorers," Investors Mutual portfolio manager Hugh Giddy said.

“Some investors buy them in the hope or belief that weather can be normal or mean reverting. I don’t particularly fancy the unpredictably of the weather and soft commodity prices."

Incitec Pivot
is often considered the largest agriculture play in Australia because about half of its earnings come from the sale of di-ammonium phosphate, which is used in fertilisers, whose prices are currently strong. But the other half of Incitec Pivot’s earnings comes from its Dyno Nobel explosives business, which is tied heavily into the mining industry, detracting from the stock’s diversification credentials.

Investors looking for more pure agriculture exposure will have to tilt their focus towards the smaller end of the market.

One place to look could be
GrainCorp
. Last week, thanks to a record-breaking east coast harvest, the company reported a bumper half-year profit of $88 million, up from $53 million in the previous corresponding period, and raised its guidance for the full year by about 25 per cent to a range of between $145 million and $165 million.

Eley Griffiths portfolio manager Brian Eley, a shareholder in GrainCorp, said there were two main arguments when it came to investing in the stock. “On one hand, you could say it’s got two great years ahead of it, and earnings momentum usually means strong share price returns so it’s time to get long," he said. “The counter-argument is that these are seasonally best conditions and therefore by buying now you are capitalising top-of-cycle earnings. But, on balance, we think earnings momentum tends to prevail."

Corporate activity has featured prominently in the sector in recent years. Some of the more high-profile deals include US agricultural services provider Agrium buying AWB, Singapore’s Wilmar International purchasing CSR’s sugar assets, while a $610 million bid from Spain’s Ebro for SunRice looks finely balanced. And deal activity could be set to continue.

“With GrainCorp, they are a perpetually in the shadow of corporate activity. If you look at their infrastructure network, it is a very valuable asset and it would be foolish to discount chances of corporate activity," Mr Eley said.

In another sign of confidence in soft commodities, Bega Cheese, Australia’s largest cheese cutting and packing company, is expected to launch an initial public offering of shares in coming months, worth up to $400 million.